Why India can’t do without China, but that’s no reason to despair

Following the release of the Economic Survey of India on 22 July, which indicated that India might need to rely on Chinese supply lines, the Narendra Modi government is considering easing investment restrictions on some Chinese companies. This move could enhance domestic manufacturing in India. The Ministry of Commerce and Industry, along with other security-related departments, are discussing whether exemptions should be granted to Chinese firms in high-tech sectors like solar modules and critical minerals.

The trend in imports from China over the decades

Imports from China have been growing rapidly since 2003-04. In the fiscal year 2019-20, China accounted for nearly 14% of India’s imports, making it the largest source of imported goods.

Before 2003-04, India’s imports from China were under $3 billion, and the trade deficit was less than $1 billion. Over the next five years, India's imports from China surged to $32.3 billion in 2008-09, while exports to China grew more slowly to about $10 billion, resulting in a $23.1 billion trade imbalance that year. Over the next decade, China’s exports to India more than doubled to $76.4 billion in 2017-18. India’s exports to China also grew, but not as consistently or rapidly, reaching $13 billion in 2017-18. That year, the trade deficit with China was a significant $63 billion, nearly 40% of India’s overall trade deficit in goods.

Hong Kong: The clever Chinese detour

The recent decline in India’s imports from China might not indicate an actual reduction in sourcing products from China. Simultaneously, imports from Hong Kong have increased considerably. Hong Kong has long been a gateway for distributing China’s products globally, importing from China and re-exporting to final destinations.

A previous study showed that between 1988 and 1998, 53% of China’s exports were routed through Hong Kong.

Since 2014-15, India’s imports from Hong Kong have consistently risen. Total imports from China and Hong Kong have increased yearly except for 2019-20, including years (2016-17 and 2018-19) when imports from China alone declined. Thus, the growth in imports from Hong Kong has more than compensated for the recent drop in imports from China.

Even the lowest ebb in bilateral relations did not change the trade pattern

Following the 2017 Doklam dispute, when sentiments in India were against China, Hong Kong started being used to tranship products made in China.

India-China relations deteriorated further after a deadly border clash in 2020, with New Delhi imposing strict rules on Chinese businesses, banning Chinese apps, and slowing visa approvals. Indian companies, especially in manufacturing, claim these restrictions have hurt their operations and hampered the government’s ability to establish India as a regional manufacturing hub.

Why not enjoy whatever benefits the enemy offers?

Nevertheless, cast our hurt nationalism aside, and we see eminent business sense in the trade with China.

The government’s annual Economic Survey, authored by the Chief Economic Adviser and released this Monday, strongly advocated for India to attract more Chinese investment to boost manufacturing. Focusing on foreign direct investment from China appears promising for enhancing India’s exports to the US, similar to how East Asian economies did in the past.

India relies on China for a wide range of products, from simple items like nails and umbrellas to sophisticated electronic products and pharmaceutical intermediates. However, India’s reliance on Chinese imports in telecom and electronics, and pharmaceutical intermediates (APIs), is particularly concerning given the criticality of these sectors for the Indian economy. Chinese dominance in telecom and electronics imports has surged since the launch of the Digital India programme in 2015, aimed at transforming India into a digitally empowered society and knowledge economy.

More importantly, India’s dependence on China for APIs has enabled Indian generic manufacturers to provide affordable medicines domestically and globally, earning the industry the nickname “pharmacy of the world.”

Indians will find it as challenging as Americans to decouple from the Chinese economy. The challenge lies in clarifying India-China relations. China remains a crucial trading partner and, unfortunately, a significant part of India's competitiveness, especially as India ventures into green technologies. As India develops domestic capacity, it needs to ensure these capabilities are advancing with technological trends. If India fails to keep up with the scale of technological advancements, it risks falling into obsolete technology. It is crucial to maintain competitive pressure while building domestic capacity. India should not be content to be technologically stagnant. Much depends on domestic competition and openness.

India might benefit more by replacing some well-chosen imports with investments from China, thus boosting Indian manufacturing and integrating India into the global supply chain as it seeks to leverage the advanced economies' push to diversify beyond China through a China-plus-one sourcing strategy.

Days of Chinese dominance numbered

Finally, rather than cursing ourselves for having to rely on the adversarial northern neighbour, India must brace for a global economy where the Chinese economy is no longer doing well, which will happen sooner rather than later.

The Chinese economy faces several urgent issues that could undermine its formidable and dominant status in the global economy. First, the debt crisis. China's total debt-to-GDP ratio stood at approximately 290% by the end of 2023, according to the Institute of International Finance (IIF). Corporate debt is a significant component, with corporate debt alone accounting for around 160% of GDP.

The real estate sector is heavily indebted. Evergrande's default in 2021 highlighted the sector's vulnerabilities, with the company having over $300 billion in liabilities.

Second, the demographic challenge. China's population is ageing rapidly. The proportion of people aged 60 and above is expected to rise from 18.7% in 2020 to 34.9% by 2050, according to the United Nations.

The Chinese birth rate has declined significantly. In 2022, China’s birth rate was 7.52 births per 1,000 people, the lowest since records began in 1949, leading to a shrinking working-age population.

Third, the slowing economic growth. China’s GDP growth rate has been decelerating. In 2023, the growth rate was around 4.8%, a significant drop from the double-digit growth rates seen in the early 2000s, according to the National Bureau of Statistics of China.

The transition from investment-led growth to consumption and services has been slow. Consumption as a share of GDP was about 38.5% in 2022, much lower compared to developed economies.

Fourth, trade and geopolitical tensions. The trade war with the United States has led to tariffs on approximately $550 billion worth of Chinese goods. This has contributed to a decline in trade growth. China’s exports to the US fell by 16.3% in 2019, according to China’s General Administration of Customs.

Geopolitical issues, such as tensions in the South China Sea and with Taiwan, have strained international relations. For instance, sanctions and export controls on technology have affected sectors like telecommunications and semiconductors.

Fifth, technological and innovation gaps. Despite progress, China remains dependent on foreign technology in key areas. For example, China imported $300 billion worth of semiconductors in 2022, indicating a significant reliance on foreign technology, according to the China Semiconductor Industry Association.

Restrictions on technology transfers, particularly from the US, have impacted China’s ambitions to become self-sufficient in advanced technologies.

Sixth — this issue is not ‘woke’, mind you — is the cost China pays due to its environmental degradation. China is the world’s largest emitter of carbon dioxide, contributing to 28% of global emissions in 2021, according to the Global Carbon Project. While China, as well as India, cannot be blamed for trying to catch up with the fully industrialised West, which attained the present economic status with unmitigated use of carbon, the cost of environmental degradation is high, with air pollution alone estimated to cost China over $900 billion annually in healthcare and lost productivity, according to a 2020 report by the World Bank.

The seventh issue with China is its social and political stability. Income inequality remains a pressing issue. The Gini coefficient, a measure of inequality, was 0.47 in 2020, indicating a high level of income disparity, according to the National Bureau of Statistics of China.

Regional disparities are evident, with coastal regions significantly more developed than the interior. For example, GDP per capita in Shanghai is over $23,000, while in Gansu province, it is less than $5,000, highlighting stark regional inequalities.

Eighth, China’s banking sector faces challenges with non-performing loans (NPLs). As of 2023, the NPL ratio was around 1.84%, but the actual figure could be higher due to opaque reporting practices, according to the China Banking and Insurance Regulatory Commission.

Shadow banking activities, although regulated more tightly in recent years, still pose a risk, with estimates suggesting that shadow banking accounts for about 60% of China’s GDP.

Ninth, which is the most pertinent to the core subject of this article — India’s dependence on the Chinese supply lines — the global shift towards diversifying supply chains away from China is gaining momentum. Foreign direct investment (FDI) into China fell by 7.3% in 2023, according to the Ministry of Commerce of China, indicating a cautious approach by global companies.

The Covid-19 pandemic accelerated the "China-plus-one" strategy, with companies looking to reduce dependency on Chinese manufacturing. Vietnam, for example, saw a 6.5% increase in FDI in 2023, partly due to this shift.

Finally, while China has made strides in innovation, it faces challenges like filing 68,720 international patent applications in 2022, the most globally, but keeping the enforcement of intellectual property rights weak, affecting global perceptions.

The need to switch from imitation to innovation is pressing. While China spends 2.4% of its GDP on R&D (World Bank, 2022), there are concerns about the efficiency and effectiveness of this expenditure compared to developed nations.

[Graphics courtesy: The India Forum]